Analysis: Is SMSF lending on the chopping block?

Westpac’s decision to pull out of SMSF lending (it will continue to service existing customers) shouldn’t come as a shock to those aware of the scrutiny surrounding these types of loans.

Fears around leveraging self-managed super funds is nothing new. When former CBA boss and current AMP chairman David Murray announced the findings of the Financial System Inquiry in late 2014, his final report urged the government to prohibit certain SMSF borrowing arrangements.

The FSI panel recommended a removal of the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements (LRBAs) by superannuation funds.

The coalition government did not move on Murray’s recommendation. But a Labor one probably would.

Last year, Labor promised to ban direct borrowing by SMSFs as part of its new housing affordability package. At the time, the SMSF Association noted that the government rejected Mr Murray’s recommendations to reinstate the ban on SMSF borrowing in 2015, stating that “there is no compelling argument to suggest anything has changed since regarding LRBAs”.

“The most recent Australian Tax Office statistics show that SMSFs hold $24.3 billion in LRBAs, with these financial instruments being predominantly used to invest in residential and non-residential property in an almost 50–50 split,” said then SMSF Association chief executive Andrea Slattery.

“That estimated $12 billion where SMSFs have used LRBAs to invest in residential housing has to be put in the context of a $6.43 trillion housing market. In other words, LRBAs comprise only 0.18 [of a percentage point] of the market. On these figures, it’s hard to argue LRBAs are a ‘market mover’.

“The idea that SMSFs have plunged into property investment in recent times also is not borne out by the statistics, with SMSF residential property holdings (both geared and ungeared) being consistent between 4 [and] 6 per cent of total SMSF assets in recent times.”

But that was last year.

“Significant concern”

On 28 June this year, ASIC unveiled the findings from a major review into SMSF advice. It wasn’t pretty.

The corporate watchdog reviewed 250 client files randomly selected based on ATO data and assessed compliance with the Corporations Act’s best interests duty and related obligations.

Property one-stop shops were identified as an area of “significant concern”.

“These models tend to promote the purchase of geared residential property through an SMSF, arranged by groups of related real estate agents, developers, mortgage brokers, accountants and financial advisers,” the report explained.

The one-stop shop model, the report said, creates inherent conflicts of interest that may affect the advice given to a client to set up an SMSF, make subsequent investments or use specific services.

“These conflicts can arise from direct or indirect commissions, referral payment arrangements, representative remuneration structures or even management pressures,” the report added.

“In light of the findings from this project, we will continue to conduct surveillance on these property one-stop shop operators and take enforcement action where appropriate.”

ASIC said that it will also work with other regulators, including the ATO and APRA, to develop a holistic approach to addressing problems that it is seeing with property one-stop shops.

This level of regulatory scrutiny, coupled with evidence about Westpac’s SMSF advice during the Hayne royal commission, makes a pretty clear argument for the major bank to pull the pin on SMSF loans.

“Eating Whiskas in retirement”

Registered nurse and Westpac client Jacqueline McDowall appeared in Hayne’s witness box back in April.

Ms McDowall, whose husband is a truck driver, approached Westpac in 2015 with a plan to buy a bed and breakfast as part of her retirement plan.

On the advice of Westpac/BT planner Krish Mahadevan, who still works at the bank, the McDowalls sold their family home and transferred their $200,000 combined superannuation balance into an SMSF.

The couple also took out life, TPD and income protection insurance costing them $27,000 per year — netting Mr Mahadevan $16,000 in upfront commissions — on the assurance that they would be able to borrow “up to $2 million” to finance the B&B.

However, after finding an appropriate property in Victoria to purchase within the newly established SMSF (which was incurring administration fees from Heffron), the McDowalls discovered that they would only be able to borrow $200,000.

After rejecting two compensation offers from Westpac, the couple accepted an FOS settlement of just over $100,000. They are currently renting in the Northern Territory where Ms McDowall is once again working as a registered nurse.

Thrive Investment Finance director Samantha Bright questioned whether the Westpac adviser was qualified to provide credit advice.

“The advice provided in this scenario makes no sense,” Ms Bright told Mortgage Business.

“The only times when I’ve seen something so far off the mark is when someone had no idea what they were doing. No idea about what the parameters around SMSF lending are, notwithstanding this was a commercial/business transaction, which just adds another layer of complexity.”

The Queensland broker, who has extensive experience in the space, said that SMSFs are a “unique beast”.

“Not just in how you lend to one, but in all the moving parts that surround the transaction itself,” Ms Bright said. “In my opinion, you can’t move one piece without it affecting a whole other area of the customer’s financial life. These loans are not easy to unwind or restructure, are expensive and can end up not just changing the financial affairs of the customer but their children and future generations of their family.

“Get your SMSF transaction wrong and you could end up eating Whiskas in retirement.”

But for now, SMSF lending is still a viable option for many. It is also an area of the market where finance professionals can set themselves apart from their competitors and carve out a niche, provided they know what they’re doing.

With Westpac out of the game, there are still a handful of SMSF lenders operating in the Australian market. The non-bank lenders, in particular, may have been given a significant advantage with these recent developments.

Unless a Labor government wins the next federal election.